Gold endured a roller coaster ride in 2016. The precious metal started the year at $1,060.10 per ounce and ended the year on $1,150 per ounce. That represents a gain of $89.90, or 8.48%. But this hardly tells the story of gold in 2016. During the year, the price of gold spiked to $1,364.90 on 6 July 2016. It dropped to $1,318.80 by 20 July, but then hit its second high of $1,364.40 by 2 August 2016. Since then, the gold price has steadily declined towards its current level of $1,150.00 per ounce. The trading range for bullion was $300 between the high and the low. This represents a 28.29% appreciation from the January 1, 2016 price.

In the early part of 2016, gold was one of the strongest-performing commodities on the market. Bullion was averaging 20% plus returns for much of the year, except for the latter part when it’s value eroded rapidly. The 30-day performance of gold is bearish, with losses of 1.78% or $20.80 per ounce. Over the past six months, gold has depreciated by 12.77% or $168.40 per ounce. Over the past five years, the precious metal is down 26.60% or $416.80 per ounce. The prognosis for gold appears to be grim; there are many better performing investments over the medium-term. Had you invested in the SPDR Dow Jones Industrial Average ETF, you would have enjoyed substantially more gains, especially since the November 8 presidential election.

Playing Offense or Defense with Gold?

This is a particularly volatile time for investors. For starters, Wall Street equities are at record highs. With the Dow Jones approaching the 20,000 level, one must consider the fundamentals of the US economy as opposed to speculative sentiment. If the excitement on Wall Street is due to the election of Donald Trump, and not the core strength of the US economy, a correction is forthcoming. This is precisely why we are seeing a tapering in equities markets as profit-taking kicks in.

Investors and day traders tend to trade carefully when equities markets rise too quickly. Nonetheless, this presents profitable opportunities for traders. If too many traders go short on equities, the markets will plunge. For now, there is enthusiasm about the possibility of a massive fiscal stimulus this year. Government-funded investment spending is the equivalent of a bolus of adrenaline to the US economy. Coupled with hawkish monetary policy, big changes are coming to the world’s #1 economy.

Will this be good or bad for gold? Smart investors recognize that it is never black and white in the financial markets. The dollar rises and falls, equities markets whipsaw at a moment’s notice, and gold remains the go-to asset during times of geopolitical uncertainty, or a risk-off approach to equities markets. Safe advice for traders is to include gold as a sizable component of a financial portfolio. Precisely how much exposure to gold an investor should have is debatable. Anywhere between 5% and 15% of one’s portfolio can be allocated to gold in one form or another.

Exchange Traded Funds (ETFs), stocks, or physical stores of bullion have proven valuable during economic downturns. Indeed, the long-term performance of gold has been positive. Over the past 15 years, Gold has returned 324.20%, or $878.90 per ounce. The 5-year performance is rather lackluster at $-416.80 per ounce. Gold is currently trading at $1,151.70 per ounce on the Comex, down 0.55% or $6.40. The spot price of gold is $1,147.50 per ounce, down 0.92% or $10.69.

Why Does Gold Fluctuate Wildly?

Gold is one of those commodities that is limited by its rarity (there is only a finite amount of gold in the earth). As such, provided there is steady demand, the price of gold bullion should continue to rise. It has multiple applications in everyday life, in electronics, jewelry, across industries and as a store of value. One of the problems with gold is that it is not an interest-bearing asset. In other words, in an economy where the interest rate is rising (such as the US), capital invested in gold will not appreciate at a fixed rate.

The opportunity cost of holding gold in such an economy is the foregone interest that would have been earned elsewhere. Gold rose consistently through most of 2016, plunging when the USD strengthened. The election of Donald Trump helped to put an end to the gold rally. The Federal Reserve Bank effectively prevented any further gains for gold in 2016. Recall that interest rate hikes strengthen demand for the USD. As demand for the greenback increases, so dollar-denominated commodities like gold bullion declines. This adds downward pressure on the gold price. Gold stocks, ETFs and futures reacted accordingly.

The current trends in the gold price indicate that the precious metal is 2+ standard deviations away from its mean. This means that gold is underpriced. All financial assets are subject to ‘reversion to the mean’, and this is precisely why momentum is building for interest in gold. It is evident that the US two-year Treasury is overbought and is a candidate for a correction. The gold price tends to behave in an opposite fashion to the US two-year Treasury bond.

Based on the assessments of analysts, it is possible that this reversion to the mean will take place in Q1 2017. We will probably see a tapering of the yield on the two-year Treasury and a concomitant increase in the price of gold. While the gold price has recorded single digit gains in 2016, gold stocks have enjoyed substantial gains. Compared to blue-chip stocks (+12.5% for 2016), the New York Stock Exchange ARCA Gold Miners Index rose 38.5%.

The Year Ahead: Gains and Losses for Gold

Interest rate hikes have a negative effect on debt repayments. The higher the interest rate, the more the US economy owes for the debt that it has accrued. According to the CBO (Congressional Budget Office), interest payments on the current debt account for 1.4% of US GDP. If the debt ceiling is raised in Q1 2017, the prognosis for gold will be positive. Regardless of the economic turbulence we may face in the year ahead, gold’s one saving grace is its rarity.

Major discoveries of new gold reserves are rare, and we are reaching saturation point in terms of what we have unearthed and what is available. Compared to 2006, the number of new gold deposits by 2015 dropped by 85%. Yearly production of gold will peak by 2019 and then gradually begin declining. These declines will invariably raise the price of gold over the long term. Markets may not see strong gains in the gold price initially, owing to recycling of gold, but the price of the precious metal will rise as supply declines.